HMO investment explained
What is an HMO?
HMO (House in Multiple Occupation), is a term used to describe a property rented out to at least three people who are not from one household but share communal areas, such as the bathroom and kitchen.
The key term here is ‘household’. A household is classed as a property used by couples who are married/living together, families or relatives. These do not fall under HMO rules.
Another term often used to describe this type of property is a ‘house share’. This could be students renting one house or workers sharing a house.
An example of this could be a four-bed house, where each bedroom has its own door lock and is let to a single tenant. The individual letting rooms are not self-contained meaning they all share a kitchen and bathroom, unlike a flat.
Typical HMOs could include:
- Shared housing
- Privately run halls of residence
- Employee housing
How do HMOs differ from traditional buy to let properties?
A buy-to-let or single let property is, for example, a house rented out to a single-family unit. An HMO property, however, is let to multiple (three or more) tenants, such as students. This will require an HMO mortgage.
There are advantages and disadvantages to both. A single buy-to-let is simpler to manage but if the tenant moves out, there could be a rental void. As this type of house has several tenants, this void is less likely.
How do HMO mortgages work?
Buy-to-let mortgages for HMO properties are simply referred to as HMO mortgages. These are mortgages used to purchase an HMO, with the property used as security for the debt.
HMOs should always be funded using HMO mortgages. Using a standard BTL product may result in you breaking your mortgage conditions and could result in your lender requesting full repayment.
Should I invest in an HMO?
Are these houses a good investment?
Landlords are attracted as they often offer greater rental yields and, in the right location, it can be easier to find tenants. Students, companies and housing associations are all good examples of likely tenants. Tenants are attracted to these properties due to the low cost of living compared to letting a full property. They are popular in high-value rental areas as the cost is shared by more paying residents.
Take the example of an HMO property used to provide housing temporary workers (e.g. contractors). Good rents will likely be received and there will be a steady stream of tenants. Even better, the company may pay the rent regardless of whether they have put a worker in there or not. This saves you the hassle of having to find new tenants every time someone moves out.
As the structure of the tenancies differs from that of a simple buy-to-let, these mortgages can be a little more complex to arrange. An experienced adviser can make the process hassle-free.
Types of HMO mortgages
Fixed, variable and tracker rates
Like with residential and BTL mortgages, HMO lending products can also be offered on fixed, variable and tracker rates.
Fixed rates are usually offered for periods of 2 to 15 years, with your monthly payments remaining the same during the fixed rate period.
Monthly payments on variable and tracker rate products would increase and decrease in line with interest rate changes each month.
Interest only or capital repayment
Most HMO mortgages are interest only, meaning only the interest is paid each month and your full balance would remain outstanding at the end of the term.
As this is considered the ‘standard’ way to do things, you won’t usually pay a higher rate for interest only loans.
How much can I borrow?
Loan to value ratio (LTV)
The maximum loan to value (LTV) currently sits at 80%. As with most mortgages, the higher the LTV, the higher the interest rate.
Some lenders offering 80% insist on a low EPC rating whilst others may prefer experienced landlords.
If you’re looking for a lower interest rate it’s worth considering putting down a larger deposit to keep the LTV down. The lowest rates tend to be at LTV’s of between 50% and 65%.
Lenders base the maximum loan size on rental coverage or a debt service coverage ratio, rather than personal earned income. This is usually between 125% and 140% of the rent and will be based on either the pay rate or a stressed rate.
Pay rate means the affordability will be based on the current interest rate whereas a stressed rate could be 2% over the pay rate, for example.
In most cases, as the rental yield with HMO’s is strong, affordability is unlikely to be an issue even at higher LTVs.
HMO mortgage rates & costs
HMO interest rates will be determined by a number of factors, namely applicant experience, the borrowing entity and the property itself.
In most cases lenders prefer the applicant to have lettings experience, a first time landlord or a first time buyer could expect to pay a higher rate than an experienced landlord.
A limited company HMO may have an increased rate when compared to an application on a personal name.
Also, a larger HMO or non-standard property will attract higher interest than a smaller more standard property.
An important factor to consider are the fees involved in arranging the mortgage. You will likely find that the lower the rate, the higher the lender arrangement fee. In most cases it works out pretty similar in cost over the fixed period.
Some lenders don’t charge arrangement fees whilst some may charge a flat fee of say £995, or a percentage of the loan. Fees of 1% to 2.5% are common.
Other fees to consider are application fees, valuation fees, legal fees and broker fees. Some lenders offer free valuation and legal fees, and no upfront costs.
A good HMO mortgage broker will take all of this into account when recommending products. Most brokers do charge broker fees, although there is still a large saving to be made if the right product is offered. Most broker fees are only payable if the loan completes, you should always be wary when paying broker fees upfront.
How to get an HMO mortgage
HMO mortgage lenders
With this type of property becoming more and more popular, there are mortgage lenders available to suit almost everybody.
The available lenders can largely be broken down into 3 main types:
- High street banks/vanilla buy to let lenders: These lenders will usually offer the best deals but will have strict criteria. They will usually have a maximum of 4 rooms with tight rules around the leases and the applicants’ experience.
- Specialist HMO lenders: These will look at slightly more complex applications and larger HMOs. Some lenders will have a specialist division, whilst being a largely vanilla buy to let lender. You may pay a slightly higher rate but will benefit from more flexible criteria.
- Commercial mortgage lenders: These lenders are ideal for those with complex HMOs, those lacking experience or those with quirks that won’t fit other lenders. You will pay a higher rate than with either of the above lenders but will benefit from the most flexible criteria.
The benefits of using a specialist HMO mortgage broker
Using a strong broker allows you to access all providers through one source. An experienced adviser will get in touch to gather key information about what you’re looking to do, and about you as a borrower, before finding the best deals to suit your circumstances.
Don’t be concerned about being asked a lot of questions when applying. The more information available, the more they’re able to support your needs. This will help you get the best deal.
The only real disadvantage is that you may have to pay a fee for this service. You should ask the adviser how much this fee is during the initial conversation.
Generally, we don’t charge broker fees for mortgages above £150,000. However, for smaller mortgages, this will be considered on a case by case basis. We aren’t tied to any one lender and are totally unbiased. Our only interest is in securing the best deal for you.
HMO valuations & conversions
How will my HMO be valued?
The main two types of valuation are as follows:
- Bricks and Mortar Valuation: This is the standard method of valuation for most types of HMO property. This type of valuation is simply of the building only and assuming it is vacant.
- Commercial Valuation or Investment Valuation: This is the value based on the overall investment or business rather than just the building itself.
Many people assume that when a property is converted, it instantly increases in value because of the rental yield. However, this isn’t strictly correct. For a standard residential house converted to an HMO, most mortgage providers will base the LTV (Loan to Value) ratio on the bricks and mortar value. This is something worth considering when looking to invest.
Take, for example, a street full of four-bed terraced houses all valued at around £100,000. All of them are either owner-occupied or let to single-family units on ASTs (Assured Short-hold Tenancies). If one of those properties was converted to a four-bed HMO, at a cost of £10,000, it would be unlikely to now value up at £180,000 for mortgage purposes. Smaller HMO’s are treated much the same as a standard buy to let property.
To obtain an investment or yield-based valuation, in most cases, you need a minimum of 6 letting rooms. This isn’t guaranteed, however, this will be subject to the valuers’ comments and due-diligence. The valuer would be looking at things like Article 4, location and how many other HMO’s there are within the area. The cost of commercial valuation can also be higher when compared to a bricks and mortar valuation.
Can I convert a property into an HMO?
This can be done, subject to planning permission. However, it’s worth bearing in mind that not all lenders will allow this.
We have access to HMO development finance products which are ideal for this scenario, regardless of the level of refurbishment involved. The interest rate will be higher whilst the refurbishment work is carried out, but a lower rate will be available when the work is complete. This is often referred to as a bridge-to-let product.
In some cases, we can arrange a property refurbishment loan whilst having the long-term mortgage pre-approved and ready to complete. In these circumstances, you can move to the cheaper long-term lending as soon as the work is complete, by taking out a HMO remortgage.
What is Article 4 direction?
An Article 4 Direction is a restriction imposed by the local planning authority to control the use of permitted development rights.
Before Article 4 came into effect, you could change the use of a property from C3 family home to C4 HMO without consent. Now, if the property is in an Article 4 area, you must apply for consent to change the use.
Is an HMO licence required?
Any property deemed a ‘Large HMO’ will need to have a valid licence in place. According to the UK government website, an HMO is considered to be large if both of the following apply:
- It is let to five or more separate tenants forming more than one household.
- Tenants all share a bathroom, kitchen and toilet.
Different councils may have different rules regarding licencing. Therefore, even if your property does not fall into the above description, it is worth contacting the local authority to find out.
You must have a separate licence for each ‘house share’ property you run. This usually lasts for five years and must be renewed before it runs out.
When applying, the council will want to make sure:
- You or your letting agent are deemed to be ‘fit and proper’ with no criminal convictions or breaches of the landlord code of practice etc.
- The property is a suitable size and facilities are adequate for the number of tenants.
The council will also require:
- That you send them an up-to-date gas safety certificate every year.
- Have adequate, maintained smoke alarms fitted.
- Provide them with safety certificates for electrical appliances.
The lender may also want a copy of any licences. If you don’t have a licence, they may look to either accept an undertaking from you to obtain one or, evidence that you have applied. If your property requires a licence, you can apply for one on the government’s website. If your application is declined, in most circumstances, you can appeal the decision.
Typically, this needs to be done within 28 days of the decision and there may be a fee to pay.
To find out more about funding HMOs enquire online now or call to speak to one of our experts on 01922 620008. Alternatively, try out our HMO mortgage calculator.